Tyson: When you're 22, what's better? Roth IRA or 401(k)?

ADVICE: PERSONAL FINANCE

ERIC TYSON

Published 6:30 am, Monday, November 21, 2005

Q: I'm 22, still in college, and I've been at my full-time job for a year now and have not participated in the 401(k). Should I invest this money that I could potentially put into the 401(k) into a Roth IRA? Which yields higher payouts in the long run if I invest, say, $2,000? And is money easier to take out of the Roth IRA than the traditional 401(k) if I need some fast cash for an unexpected expense? Or is a CD the way to go? I am making hardly any interest in my savings account.

A: Kudos to you for getting into the habit of saving for the future when you first enter the work force.

The answer to your question is that it depends upon a number of factors. Most people are better off taking the upfront tax break, which is what you get with a 401(k) plan. But because you are so young and presumably not in a high tax bracket, you might come out ahead with the Roth IRA.

With the Roth IRA, while you contribute after-tax dollars, your investment earnings are not taxed upon withdrawal so long as you're at least age 59 1/2 and you have had the Roth IRA for at least five years. The age 59 1/2 rule is waived for up to $10,000 in withdrawals for first-time home purchases.

If the 401(k) plan offers free matching money for contributions, that might tip the scales back in favor of the 401(k) plan. If you're concerned about tapping this cash in an emergency, ask your employer's benefits department what the plan's rules are regarding loans.

T. Rowe Price has some useful tools on its Web site at www.troweprice.com that will allow you to compare retirement account options when you plug in differing assumptions.

I don't think a CD is the way to go if you're looking for competitive returns and emergency access to your money.

Q: I was just blessed with a grandson, and I would like to invest for him monthly. What would you suggest?

A: Congratulations! As I have advised in the past, don't put the money in your grandson's name, because it might hurt his ability to qualify for college financial aid. Better to give the money to his parents and allow them to invest it.

Some people are afraid of doing this out of fear that the money could be misused. Talk to the parents about your guidelines for the money and discuss investment options. You probably have a feel for how responsible they will be.

If you're concerned they might not use the money as it was intended, you could try some other approaches. One would be for you to invest the money in your own name and then pay for his college expenses when the time comes. Another would be to place the money in a trust for the child. Speak with a tax adviser experienced with such trusts about their pros and cons.